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Singapore has already developed an enviable reputation as a global fund management hub. Yeo Wico and Suhaimi Zainul-Abidin discuss the new regulatory and tax approaches being adopted to encourage the growth of Islamic funds in the country

The rise and rise of Singapore as a fund management center

Singapore’s emergence as one of Asia’s leading asset management hubs in the last 10 years has been nothing short of inspirational. Today, Singapore is seen as an attractive, robust and continually growing asset management hub. As at the end of 2011, the industry’s assets under management stand at SG$1.34 trillion (US$1.08 trillion), resulting from a five-year AUM growth of 11% per annum. Much of this development can be attributed to the deliberate and measured introduction of tax measures in Singapore to make it a compelling location for fund managers and investors alike.

Based on the Monetary Authority of Singapore (MAS)’s 2011 Singapore Asset Management Industry Survey, more than 70% of the total AUM of funds in Singapore are sourced from outside Singapore, demonstrating that it still primarily plays the role of serving regional and international investors. Given the continuing socio-political unrest in the Middle East, and the troubled and uncertain financial markets and economies in the US and Europe, Shariah-sensitive funds are likely to continue to head east for the foreseeable future, towards established Islamic financial centers like Malaysia and aspiring Islamic fund management centers like Singapore.

Tax incentives in Singapore

There are a number of factors that a fund promoter takes into consideration when establishing a fund. These are firstly to protect the fund and the investors from tax issues that arise from the way the fund manager is structured and operated; secondly, to minimize tax costs for the fund which are independent of the fund manager’s structure; and thirdly, to minimize tax on the fund manager’s own income from managing the fund. In this regard, the following safe harbor provisions have been introduced in Singapore, to deal with all of the three considerations above.

Tax exemptions for offshore funds
An offshore fund that is managed by a Singapore-based fund manager is exempt from tax on specified income from designated investments (such as stocks, shares, securities, bonds, deposits and futures contracts), provided the offshore fund is a qualifying fund. A qualifying fund is generally one that: (i) is not resident in Singapore, (ii) is not 100% beneficially owned by Singapore investors, (iii) does not have a Singapore presence, and (iv) is in the form of a company, trust or individual account.

In addition, each of the investors in the fund needs to be a qualifying ‘relevant owner’ in order to enjoy the tax exemption on their share of the fund’s income and gains. An investor will generally not be a qualifying relevant owner if he (together with his associates) is a Singapore based non-individual who owns more than 30% (or 50% in certain cases) of the fund.

Tax Exemptions for Onshore Funds
Pursuant to the Singapore Resident Fund Scheme, the abovementioned tax exemption scheme for offshore funds applies equally to funds constituted in Singapore, subject to the above conditions and that: (i) the fund vehicle is a company, (ii) the fund is constituted in Singapore and has its administration performed in Singapore, and (iii) the fund is approved by the MAS. This scheme was introduced to encourage fund managers to base their fund vehicles in Singapore, to gain access to Singapore’s large tax treaty network which now stretches to over 70 countries.

Enhanced tier fund management scheme
Under the Enhanced Tier Fund Management Scheme, which applies to both onshore and offshore funds, tax exemptions are provided for specified income on designated investments. The scheme does not place any restrictions on the percentage of Singapore investors in the fund and has fewer restrictions over the choice of fund entity or its place of constitution or residence, but the scheme only applies to funds with a minimum size of SG$50 million (US$40.4 million) at the point of application and provided certain additional conditions are met.

Concessionary tax rate for fund managers and Islamic fund managers
Under the Financial Sector Incentive Scheme for Fund Managers, fund managers in Singapore are taxed at a concessionary rate of 10% on fee income, subject to certain conditions and MAS approval. This scheme applies to fund managers who employ at least three fund management or investment advisory professionals whose basic monthly income must exceed SG$3,500 (US$2,831).

A further concessionary rate of 5% applies for qualifying Islamic fund managers on qualifying income derived by (i) an approved Financial Sector Incentive company (under the FSI (Islamic Finance) enhanced tier award) from lending and related activities and management of Shariah compliant funds and provision of investment advisory services in relation to Shariah compliant funds, and (ii) an approved or general life insurer from offshore Takaful or re-Takaful business. However, the window approval period ends on the 31st March 2013 and the renewal of this incentive scheme will be a closely watched item in the upcoming budget to be announced by the Singapore government in the first quarter of 2013.

The take-up of the FSI (Islamic Finance) enhanced tier award is still in its early days, but the first few examples underscore that there are no regulatory or market impediments to the establishment of Islamic funds in Singapore, and this provides a basis to be optimistic about the future embrace of this unique additional advantage afforded to Islamic funds over conventional funds.

Unique characteristics of Islamic funds

The essence of an Islamic fund is its compliance with Shariah. Accordingly, fund managers need to take into account a number of specific issues before establishing an Islamic fund. They must understand and decide on their investment mandate (which excludes investments proscribed under Shariah), their Shariah board, Shariah audit guidelines, methodology for the purification of non-Shariah compliant income, and asset screening parameters (for Shariah compliance). None of these additional considerations are in any way insurmountable if the proper expertise is engaged, but the additional procedures are naturally expected to result in some additional cost to the fund.

Some of these specific issues are elaborated on below.

Shariah board
Shariah-compliant funds must appoint a Shariah board to provide guidance to the fund manager and the investment manager on all matters of Shariah relating to the fund, particularly on the Shariah compliance of proposed investments. The Shariah board will determine whether the fund’s structure, investment guidelines and documentation are Shariah compliant and will issue a Fatwa confirming this.
The importance of selecting the appropriate scholar cannot be overstated from a branding and marketing perspective, particularly for funds adopting new or sophisticated structures.

Shariah audit
Shariah compliant funds will need to be audited on an annual basis to ensure continued compliance with Shariah principles. This audit role can be performed by the fund’s scholars or third parties.

Purification
Income generated by a Shariah compliant fund must also be ‘purified’ if it is generated from underlying investments that are not Shariah compliant. There are a number of different ways to purify such income, with the end result usually that such income will be donated to charity. In this respect, involvement in non-Shariah compliant investments may to such extent affect the profitability and returns of the fund and investors.

Documentation
The fund documentation, including the private placement memorandum, will need to expressly state that the fund is established for Shariah compliant purposes, and provide for the manner in which the structures adopted and investments made will be approved and monitored for Shariah compliance. In addition, all other aspects of the fund documentation must also be Shariah compliant. For instance, investors may not be charged interest for late payment of commitments, but can instead be charged a late payment penalty which must then be donated to charity.

Leverage
Various types of investment funds (including Shariah compliant funds) typically seek to leverage their investments. Because Shariah compliant funds are not permitted to take up mainstream borrowing which is prohibited under Shariah, they have to seek Shariah compliant financing (commonly through commodity Murabahah financing techniques) and it is therefore important for funds to be established in jurisdictions where Shariah compliant financing and hedging instruments are readily available.

Singapore’s approach to Islamic fund management

In Malaysia, a leading Islamic finance hub, Islamic fund management companies (IFMCs) may be established if licenced by the Securities Commission of Malaysia (SCM). IFMCs must, among other things (i) appoint a Shariah adviser which can be an individual or corporation, or an Islamic bank or a licenced institution approved by Bank Negara Malaysia, the central bank, to carry on an Islamic banking business, in each case, approved by the SCM; (ii) ensure that its investment activities are limited to Shariah compliant investments; (iii) maintain all accounts in accordance with Shariah principles; (iv) undertake appropriate Shariah compliant risk management techniques and tools for its Islamic fund management business; (v) perform internal audits to monitor Shariah compliance; and (vi) prepare a written disclosure and declaration to the SCM that the Islamic fund management business has been carried out in accordance with Shariah principles. In addition, members of the Shariah committee of IFMCs are required to be of good repute and character and possess the necessary qualifications, expertise and experience (particularly in Fiqh Muamalat) to perform his or her duties and responsibilities in a fit and proper manner. These regulations are reflective of the generally highly regulated nature of the Islamic finance industry in Malaysia.

[This article is intended to provide general information. The information herein should not be treated as a substitute for specific legal advice concerning particular situations.]Yeo Wico and Suhaimi Zainul-Abidin are partners at Allen & Gledhill Singapore.